A Long Fall for Taiwan Smartphone Maker

By CAIN NUNNS

September 8, 2013

TAIPEI — Just two years ago, HTC, the Taipei-based mobile devices maker, was riding the crest of exploding global premium smartphone sales. It was racking up awards, a record stock price and a string of acquisitions, and was busy poaching rival executives for a continued assault on the dominance of Apple, Samsung and Research In Motion.

Those days are little more than a memory. Its stock price has plummeted more than 88 percent since its April 2011 high. Profits for the second quarter, which ended June 30, were down 83 percent. The company warned that the third quarter looked bleaker still.

It gets worse.

Several of those poached executives, brought onboard to help increase shipments and work on acquisitions have walked away, and there is a growing chorus for the ouster of the embattled chief executive, Peter Chou, as reports filter out of Taipei about an autocratic leader who is out of touch with the industry.

There were also the arrest last week of five departing executives accused of stealing company secrets and padding expense accounts. HTC had filed a complaint against the executives, who included the vice president of product design, Thomas Chien, and the research and development director Wu Chien-hung.

“We are cleaning up inventory and at the same time rebuilding our brand,” said the company’s chief marketing officer, Ben Ho. “If we don’t, there really is no tomorrow for us. The shock came last year. This year we have tried to repent. Are we forgiven? No, the markets will punish you if you don’t repent and recover fast enough.”

Former employees say that marketing, sales and distribution problems, along with spiraling inventory costs, have killed momentum and are dragging HTC into unprofitability.

In the quick-moving mobile devices industry, a lack of momentum is tantamount to a death sentence. Just ask Motorola or BlackBerry.

HTC set up shop as a contract electronics maker in 1999. Founded by Cher Wang, daughter of the billionaire former chairman of Formosa Plastics, Wang Yung-ching, it had to worry only about its margins. The clients took care of the rest. Business was good.

In 2002, it listed on the Taiwan Stock Exchange, starting a run of profitable quarters that will most likely be snapped with the next earnings report. HTC has said that it expects an operating margin of zero or a loss of as much as 8 percent for the third quarter.

By 2006 it had grown weary of slapping other companies’ brand names onto its products and decided to go it alone. A few years later, HTC developed the first smartphone that used Google’s Android operating system.

“HTC has always made great products,” said a recently departed executive, who spoke on condition of anonymity because of the sensitivity of the situation. “There are no problems on the hardware side of the ball. It just can’t sell to save itself. It’s relied too heavily on operator subsidies, and those are drying up for the premium phone market HTC likes to play in.”

The market research firm Gartner said that HTC had shipped 24.6 million smartphones in 2010, accounting for about one in every 12 smartphones bought globally. In 2011, that share increased to 9.1 percent, with purchases surging to about 43 million units.

In Taiwan, HTC was feted in the local media as the little company that could — the former contract maker now on the big stage for its innovation. Politicians urged the public to buy patriotically. HTC was an electronics flag bearer.

The company went on an acquisitions binge, spending more than $700 million, including splashy purchases of the U.S. graphics maker S3 Graphics for $300 million and the premium headphone maker Beats Electronics for $309 million.

Beats, founded by the hip-hop producer known as Dr. Dre, viewed it as a company on the rise when it sold HTC a 51 percent stake. Investors grumbled that HTC had overspent. Beats eventually bought back half of HTC’s stake in 2012 for $5 million less than it had been paid and is looking to purchase the remaining shares.

By 2012, according to Gartner, HTC sold about 32.1 million smartphones. Market share plunged to 4.7 percent. It did manage, however, to resolve a long-running, costly and distracting patent dispute with Apple by agreeing to a 10-year licensing term from the technology giant.

Gartner says HTC sold about 5.4 million smartphones in the first quarter of this year. Its market share fell again — this time to 2.5 percent. Many of the foreign executives brought in to oversee the acquisitions or sales and marketing left or were let go.

“They were too diversified,” said Jason Chien, a former mobile phone analyst with Topology Research Institute in Taipei. “Their portfolio was a mess and they wanted to make Android, Microsoft and Facebook phones. They should have concentrated on Android, instead of wasting their money on Windows and Facebook.”

The second quarter improved slightly when it sold about 5.9 million units, amounting to 2.6 percent of market share.

The flagship HTC One model, widely praised by reviewers as an impressive piece of hardware, was supposed to lift sales. Its release, however, was delayed until April. When it did make it to market, suppliers had problems manufacturing enough of the premium parts to keep up the momentum.

In a Goldman Sachs research note in August, which downgraded HTC’s stock from neutral to sell, the investment bank warned that it did not expect the company to return to profitability until the second quarter of 2014 at the earliest.

The report pointed to “limited clarity on strategies” and HTC’s recurring inventory problems and said that “sales execution and channel management remain below industry standards.” Other issues were that the company was potentially burning cash because of a “deteriorating product cycle” and the possibility of more debt.

Members of the company’s staff who were not authorized to speak on the record said it was too focused on the “super premium” phone market and was oblivious to a slowdown in that segment, while ignoring the booming midrange and lower tiers in developing countries like India and Indonesia.

C.K. Lu, an analyst with Gartner, said, “HTC doesn’t know how to make a cheaper phone. It isn’t in their DNA. They don’t know how to do it by cost, or differentiate. They usually downgrade from their premium segment and that doesn’t work. It’s a very, very old-fashioned approach.”

Mr. Chou, who joined HTC in 1997 and has led the company for a decade, is viewed as a workaholic design guru who worships at the temple of innovation and quality. His critics say he is aloof and autocratic and does not realize that a great product will not fix sales, marketing and distribution problems.

“The company is in trouble and Peter has to own that,” said Wong Teck Zhung, an analyst with the market research firm IDC. “The clock is ticking. If he can’t turn around the bottom line and morale this year, I would expect some change at the top.”

Mr. Chou declined interview requests.

But Mr. Wong and others also caution that the company has no clear internal successor. Because of HTC’s top-heavy Taiwanese corporate culture, it would be extremely difficult to replace him with somebody from the outside.

“They have got to keep the ship steady for now. If they change captain, it’s going to be one issue after another — an endless stream of them,” Mr. Wong said.

HTC hopes that the release last month of HTC One on the U.S. carrier Verizon and the introduction of its midrange phone, the One Mini, will help improve sales.

“They are stuck in quicksand. They think the launch of the flexi models will get them out. But the market is sucking them back in. They won’t get back to the heights of 2010 and 2011,” Mr. Wong said.

Staff members dismissed recent reports that the company was looking to merge with another company and played down speculation that it was ripe for a hostile takeover by Chinese vendors like the surging Lenovo Group.

HTC, which had a market capitalization of $4.4 billion in late August, announced a buyback of 15 million shares that month. The buyback represents about 1.8 percent of its outstanding stock.

“The markets are not here to forgive us,” said Mr. Ho, the chief marketing officer. “Investors want profits and we are being punished for that. Consumers and operators are not messed with. They will remember you forever.”

“It is very challenging,” he added. “I won’t deny that. But management believes we have a good chance to come back. We aren’t short of cash and we have no intent to sell.”